The Treasury's decision to stop issuing 30-year bonds sent the fixed-income market into disarray. Which may have been exactly what officials had in mind.
Prices on long-dated bonds of all sorts rose sharply Wednesday, driving yields down as a buying frenzy ensued. Juicing the rally, many bears who had bet that long rates would stay high were forced to cover their short positions. That drove prices higher still.
The persistently high yields on long-term Treasury and corporate debt have long stuck in policymakers' craw. Because borrowing costs remained high, this year's Fed rate cuts haven't succeeded in restarting the economy. Ironically, this was partly because market participants believed the cuts would do their job, reviving growth and pushing the Fed back into a tightening cycle. Federal Open Market Committee minutes reveal concern that long rates weren't falling even as short ones plunged. But other than cutting the short-term funds rate more and hoping, there was little members could do.
Source: Federal Reserve
But the Treasury's hands weren't so tied. Jim Bianco, the president of Bianco Research, calls today's action a John Gotti move -- send long rates down or we put cement shoes on them and dump them in the East River. Some market watchers see the decision as another government effort to stimulate the economy, Treasury's comments notwithstanding.
Regardless, whether long-term rates will stay low is an open question. Some bond traders recalled what is referred to as Operation Twist in the early 1960s, when Treasury under secretary Robert Roosa tried to raise short-term rates and cut long-term rates through financing opertions. The enterprise is widely viewed as having failed.
"In the end, the bond investor invests in bonds on assumptions about inflation and opportunity costs compared to other assets," says Miller Tabak bond strategist Tony Crescenzi. Moreover, points out Goldman Sachs director of U.S. economic research Bill Dudley, it's not as if the Treasury had been issuing all that much 30-year debt lately -- only about $15 billion worth in the past year. "I'm sure the Fed would be happy if long yields were to fall," he says. "But I'd be surprised if there was a big effect."
Yet just because the end of the 30-year shouldn't have an effect doesn't mean that it won't. These are markets, after all, and people sometimes overplay their hand. The sharp move today suggests that the traders who had bet on further yield curve steepening -- that short-term rates would fall faster than long-term rates -- may have overplayed theirs. One recalls how, in 1998, the Treasury Department went into the currency markets and completely reversed the course of the dollar. One recalls all the naysayers who said it wouldn't work.
One thinks that Bob Rubin might be smiling now.